Prepared by: Brian Christian S.

Villaluz, CPA

Service Department Cost Allocations

Two types of overhead costs:
1 Directly related to the operating activities (primary revenue – generating)
2 Indirectly related to the operating activities

Support departments – include both service and administrative departments.

o Service department – an organizational unit that performs functional tasks for other
internal units.
o Administrative department – perform management activities that benefit the entire
organization.

METHODS OF ALLOCATING SERVICE DEPARTMENT COSTS

1 Direct method – assigns support department costs only to producing departments.
- the simplest allocation method.
- No consideration is given to service performed by one service
department for another service department.

Service Dept. 1
Producing Dept. 1

Service Dept. 2
Producing Dept. 2

2 Step method – allows a partial recognition of the effects of interaction among

support departments.
- No cost is assigned to service departments whose costs have already
been allocated.

Service Dept. 1
Producing Dept. 1

Service Dept. 2
Producing Dept. 2

Benefits-provided ranking – begins with the support department providing the most
service to all other support areas and ends with the support department providing the least
service to all other support areas.
o Those of the service department that provides the highest percentage of its total
services to other service departments.
o Another is to begin with the costs of the service department providing services to the
greatest number of other service departments.
o Another is to begin with the service department having the greatest peso cost of
services provided to other service departments.

3 Algebraic method – considers all departmental interrelationships and reflects these

relationships in simultaneous equations.
 Prepared by: Brian Christian S. Villaluz, CPA

- the most complex of all the allocation techniques but it is the most
theoretically correct and provides the most accurate and reliable
allocations.

Service Dept. 1
Producing Dept. 1

Service Dept. 2
Producing Dept. 2
 Prepared by: Brian Christian S. Villaluz, CPA

ACTIVITY-BASED COSTING (ABC)

Problem 1:
Weng Office Equipment Corporation manufactures two types of filing cabinets – Deluxe and Executive – and
applies manufacturing overhead to all units at the rate of P80 per machine hour. Production information follows:
Deluxe: Executive:
Direct material cost P40 P65
Direct labor cost 25 25
Budgeted volume (units) 16,000 30,000

The controller, who is studying the use of activity-based costing, has determined that the firm’s overhead can be
identified with three activities: manufacturing setups, machine processing, and product shipping. Data on the
number of setups, machine hours, and outgoing shipments, which are the activities’ three respective cost drivers,
follow:

Deluxe: Executive: TOTAL:

Setups 100 60 160
Machine hours 32,000 45,000 77,000
Outgoing shipments 200 150 350

The firm’s total overhead is subdivided as follows: manufacturing setups, P1,344,000; machine processing,
P3,696,000; and product shipping, P1,120,000.

1. Compute the unit manufacturing cost of Deluxe and Executive filing cabinets by using the company’s
current overhead costing procedures.
2. Compute the unit manufacturing cost of Deluxe and Executive filing cabinets by using activity-based
costing.
3. Is the cost of the Deluxe filing cabinet overstated or understated (i.e. distorted) by the use of machine
hours to allocate total manufacturing overhead to production? By how much?
4. Calculate the aggregate amount by which the Deluxe cabinet line is undercosted by the company’s
current traditional overhead costing procedures. Then calculate the aggregate amount by which the
traditional system overcosts the Executive cabinet line.
5. Assume that the current selling price of a Deluxe filing cabinet is P270 and the marketing manager is
contemplating a P30 discount to stimulate volume. Is this discount advisable?

Problem 2:
The following data are for the two products produced by Aplan Company:

Product A: Product B:
Direct materials P15/unit P24/unit
Direct labor hours (DLH) 0.3 DLH/unit 1.6 DLH/unit
Machine hours (MH) 0.1 MH/unit 1.2 MH/unit
Batches 125 batches 225 batches
Volume 10,000 units 2,000 units
Engineering modifications 12 modifications 58 modifications
Number of customers 500 customers 400 customers
Market price P30/unit P120/unit

The company’s direct labor rate is P20 per DLH. Additional information follows:

Costs: Driver:
Indirect manufacturing
Engineering support P24,500 Engineering modifications
 Prepared by: Brian Christian S. Villaluz, CPA

Electricity 34,000 Machine hours

Setup costs 52,500 Batches
Non-manufacturing:
Customer service 81,000 Number of customers

1. Compute the manufacturing cost per unit using the plant-wide overhead rate based on direct labor
hours. What is the gross profit per unit?
2. How much gross profit is generated by each customer of Product A using the plant-wide overhead
rate? How much gross profit is generated by each customer of Product B using the plant-wide
overhead rate? What is the cost of providing customer service to each customer? What information is
provided by this comparison?
3. Determine the manufacturing cost per unit of each product line using ABC. What is the gross profit
per unit?
4. How much gross profit is generated by each customer of Product A using ABC? How much gross
profit is generated by each customer of Product B using ABC? Is the gross profit per customer
adequate?
5. Which method of product costing gives better information to managers? Why?

SERVICE DEPARTMENT COSTS ALLOCATION

Adidas Inc. is exploring ways to allocate the cost of service departments such as Quality Control and Maintenance to
the production departments such as Machining and Assembly. The controller of the company has provided the
following information:

Quality Maintenance Machining Assembly TOTAL:

control
Budgeted overhead P350,000 P200,000 P400,000 P300,000 P1,250,000
costs before allocation
Budgeted machine - - 50,000 hours - 50,000 hours
hours
Budgeted direct labor - - - 25,000 hours 25,000 hours
hours
Budgeted hours of - 7,000 hours 21,000 hours 7,000 hours 35,000 hours
service of quality
control
Budgeted hours of 10,000 hours - 18,000 hours 12,000 hours 40,000 hours
service of maintenance

1. Under direct method of allocating service department costs, what are the total service costs allocated
to the machining and assembly departments, respectively?
2. Under the step-down method of allocating service department costs from quality control to
maintenance, what are the total service costs allocated to the machining and assembly departments,
respectively?
3. Under the reciprocal method of allocating service department costs, what are the total service costs
allocated to the machining and assembly departments, respectively?
4. In relation to item no. 3, what are the total service costs allocated to the machining and assembly
departments, respectively?

END
 Prepared by: Brian Christian S. Villaluz, CPA

AFAR Answer Key

PROBLEM 1 Answers:
1. Deluxe – P225/unit; Executive – P210/unit
2. Deluxe – P253.50/unit; Executive – P194.80/unit
3. Understated by P28.50/unit
4. Deluxe – P456,000 undercosted; Executive – P456,000 overcosted
5. No.

PROBLEM 2 Answers:
1. A B
Mfg. cost/unit 26.37 84.65
Gross profit/unit 3.63 35.35

2. A B
Gross profit/customer 72.60 176.80
Customer service/customer 90 90

3.. A B
Mfg. cost/unit 24.29 95.02
5 5
Gross profit/unit 5.705 24.97
5

4. Yes A B
Gross profit/customer 114.1 124.87
0 5
Customer service/customer 90 90

5. ABC

PROBLEM 3 Answers:
1. P382,500; P167,500
2. P372,000; P178,000
3. P421,053; P284,211
4. P380,527; P169,474